Quarantining

In the context of the foreign tax credit (FTC) system, quarantining refers to the practice of separately calculating the foreign tax liability for different categories of foreign income. Each category of income has its own limit for claiming foreign tax credits. This means that the foreign taxes paid on income in one category cannot be used to offset the domestic tax liability on another category of income. Purpose of Quarantining To prevent taxpayers from using excess foreign tax credits from one income type to reduce domestic tax on another income type. Ensures that tax credits are properly matched with the specific income class to which they relate. How It Works Foreign income is classified into categories (e.g., passive income, business income, capital gains). For each category: The foreign tax paid is calculated. The domestic tax on that same category is computed. The foreign tax credit is limited to the domestic tax payable on that category. Unused foreign tax credits in one category cannot be applied to another. Example (Simplified) If a taxpayer earns: Foreign passive income taxed at 30% abroad Foreign business income taxed at 10% abroad They must compute tax credits for each type separately. Excess credit from the passive income category cannot reduce domestic tax owed on business income.